1. 15©
11th
June 2014
SPECIAL REPORT
The most pressing challenge faced by the
Islamic finance industry is the increasing
cynicism among existing and potential
customers — overly-engineered financial
products are seen to be moving towards
a trend whereby products are being
designed to comply with the technical
requirements of Shariah but appear
similar to their conventional counterparts.
Islam provides an alternative financial
paradigm: and focusing on the spirit and
purpose (Maqasid) of Shariah, the aim
of this article is to move past Halal and
Haram to emphasize the clear gradations
in the actions of a Muslim that have been
defined in Islamic teachings. We also look
at how these can be applied to a new
methodology of rating financial products.
Concepts such as Tayyab, Mandoob
(recommended) and Makruh (disliked), are
equally relevant when creating a ratings
methodology and eventually a range
of products that provide a choice to the
ultimate user of Islamic finance to opt for
enhanced value-based products.
This new proposed rating methodology
not only looks at the compliance to
Shariah principles of financial products
but also rates them according to their
positive social impact to society based
on Shariah teachings. The investment
methodology would be known as ‘Shariah
Impact Investment’and would be, to our
knowledge, the first of its kind.
Apart from a religious point of view, there
is an extensive body of global research
showing that ethics based investment
methodologies in most cases tend to
outperform the market.
Current Shariah screening
practices
The only difference between most Shariah
screening methodologies globally is
the type of financial ratios applied to
determine Shariah compliance; otherwise
core screening methodology remains the
same and provides no Fiqhi’gradation in
the type of companies that make up the
investment universe.
Maqasid’ Al Shariah
Maqasid’Al Shariah means the purpose
of Islamic law. Scholars have classified the
Maqasid into three descending categories
of importance:
1) Darurat (essentials): There are five
absolute requirements to the survival
and spiritual well-being of individuals
and maintaining order within society,
absence of which would lead to
anarchy and chaos. These include the
preservation and protection of: Religion
(Al-Din), Life (Al-Nafs), Progeny
(Al-Nasl), Intellect (Al-Aql), Wealth (Al-
Mal).
2) Hajat (supporting needs): Benefits
that seek to remove hardship in cases
where hardship does not pose a threat
to the survival of the normal order. The
benefits are normally recognized as
being concessions, which makes things
easier but are not required.
3) Tahsinat (complimentary interests):
These are actions which seek to
attain perfection in the customs and
conduct of people at all levels. These
embellishments should pervade
through the above two Maqasid.
Examples of adhering to Maqasid’Al
Shariah can be can include providing help
and assistance to those who need them
in the society, demonstration of social
responsibility in the market, facilitating the
process of cash-flow, increasing wealth in
society through permissible means, etc.
Developing a Maqasid-based
rating methodology
The focus now shifts towards the
development of the first advanced positive
Shariah impact rating. This methodology
would look to classify businesses and
financial assets based on the criteria of
Maqasid’Al Shariah, i.e., Shariah impact.
Using the Shariah Impact Methodology,
the equities/assets would be assigned
one of three ratings based on the Islamic
judgments of actions:
1) Tahsinat
2) Mubah
3) Esasiya
Tahsinat would be the highest rating,
indicating that the said financial asset
(equity, bond, Sukuk etc.) adheres to the
teachings of Islam to a higher degree
and creates a societal impact vis-à-vis
Maqasid’Al Shariah, while Esasiya would
be at the bottom end of the spectrum
having the least Shariah impact.
It should be noted that this methodology
builds upon existing Shariah screening
methods and aims to be an evolution. This
evolution is also observed in conventional
non-Islamic investment methodologies,
which have evolved from simple financial
screening to negative screening and then
onto positive social impact screening.
The aim is to give serious Muslim investors
a platform to gauge the Shariah impact of
Shariah impact rating methodology — a new
way to rate Shariah compliant products
The Islamic finance industry experiences continuous double-digit growth worldwide but it still faces a number
of challenges, ranging from governance issues to lack of qualified professionals. MUJTABA KHALID proposes a
revolutionary new ratings system for Shariah products, which suggests an entirely new outlook on the Shariah.
Core screening Financial
Shariah compliant
stocks
Figure 1: Current Shariah screening methodologies
Figure 2: The hierarchy of Maqasid’Al Shariah
Tahsinat
Hajat
Darurat
continued...

2. 16©
11th
June 2014
SPECIAL REPORT
their investments — both for the benefit
of society and to receive a higher reward
in the form of Allah’s blessings as well as
financial returns.
Overview
The Shariah Impact Rating Methodology
will take a multi-faceted approach:
Equity universe: For equity screening, we
start off by defining the available equity
universe. These would be equities pre-
defined in the Shariah index of the country
specific bourse. For example, for US
equities in the S&P Shariah index would
be used, for Pakistan the Meezan Bank
Shariah index, for Malaysia the SEC index
and so on. For private equity investment
ratings or rating other financial products,
we would start off by first determining
whether the underlying investment is
Halal and then move on to the steps
mentioned below.
Sector weightage: The first step would be
the rating of equities in terms of the sector
they belong to for example basic materials,
health care, industrials etc. Some sectors
would carry higher weights compared to
others. The weights will be based on the
Shariah impact on society as well as Islamic
teachings and traditions. For example if we
look at the following Quranic Verse:
“...And We send down iron, in which
there is great strength and benefits for
mankind…” [57:25]
It can be concurred that iron is a blessing
for mankind, therefore using this as an
analogy, companies involved in metals
and mining will have a positive weight.
Using this approach, a metrics would be
developed that rates certain sectors higher
than others.
Product impact weightage: The next step
would require the assessment of the
Shariah impact of the company’s product
or service. Weights would be assigned
according to the positive Shariah impact
created by the product.
Business operational weightage: The last step
would require taking a detailed view of
the company’s operational mechanisms
–both internal and external and giving
weightages accordingly. Two aspects of a
company would be looked at in this step:
• Internal business practices — corporate
governance, organizational behavior,
treatment of employees
• External business practices — corporate
social responsibility, interactions
with stakeholders such as customers,
shareholders etc.
Rating methodology
Each of the first two steps would be given
a weightage of 10 points each and the last
step would have a total weightage of 20 (10
for internal business practices and 10 for
external).
Product impact and business operational
weightages would have sub-categories
within them but as mentioned above, the
total weightage when it comes to rating
would be 10 for Product Impact and 20 for
business operational weightage.
All equities (and other assets) which score
above 30 would be rated as Tahsinat,
below 30 and above five would be rated
as Mubah and the remaining would be
categorized as Esasiya (very basic Shariah
compliance).
Mujtaba Khalid is a senior associate with
the UK Islamic Finance Council, and can be
contacted at mujtaba@ukifc.com.
Figure 3: Example of product Shariah impact weightage metrics
Subject Shariah/Social impact of product
Facilitates access to clean water
Facilitates access to education
Facilitates access to financial services
Facilitates access to information
Facilitates access to affordable housing
Facilitates agriculture productivity
Facilitates capacity building
Facilitates community development
Facilitates conflict resolution
Facilitates employment generation
Facilitates equality empowerment
Increases food security
Facilitates health improvement
Aids human rights protection or expansion
Increases income/productivity growth
Beneficiary demographic
targeted by organization’s
product or services
Children and adolescents, disabled, minority.
Previously excluded populations, women
Socioeconomic group of
beneficiaries targeted by
organization’s product and
services
Very poor, poor, Low income
Target beneficiaries setting Rural
Figure 4: Shariah Impact Rating Methodology
Universe of Shariah compliant equities
Sector weight Product impact weight Business Op. weight Rating
Positive weight if a
company operates
in sector that are
considered noble
in Islamic teaching
or sectors which are
essential to society
e.g. Mining, health,
care, agriculture,
utilities
Positive weight if
the main product
(or product range)
of the company
has a positive
impact on society
or individual e.g
access to clean
energy, increased
agricultural
productivity,
construction of
affordable housing
Internal business
practise weighted
sub-categorized
based on corporate
governance etc
External business
practises-weighted
sub-categories based
on CSR etc.
Total of 10 Total of 10 Total of 20
Tahsin
Mubah
Esasiya
Continued